ACCOUNTING CONVENTIONS AND STANDARDS
Accounting conventions (or assumptions) are the basic rules of accounting which have become acceptable procedures over time. They are the basic rules of accounting. Accounting standards are laws for members of the professional bodies to follow.
Together they form a set of rules which allow accounting records and reports to be prepared in a similar fashion, regardless of the type of business or the form of ownership. The more important conventions are as follows:
The accounting entity convention is the basic principle that the personal transactions of the owner(s) should be kept separate from those of the business. The business is always viewed as a separate entity, regardless of whether the firm is a sole trader, a partnership or a company.
The historical cost convention is a rule which states that all transactions are recorded at their original value, and adjustments are not made for inflation. This means that assets are not valued at what they could be sold for at the present time. All items stay in the accounting records at their historical or original price. This method is quite objective, as it relies on document evidence such as invoices and receipts. There are some exceptions to this rule, for example with land. Unlike most assets which lose value over time, land normally appreciates in value and may be revalued in some circumstances.
The going concern assumption conceives that a business will continue as a ‘going concern’ for an indefinite period. By following this rule, accountants can report long-term assets in a balance sheet. Otherwise they would all have to be written off as costs in their year of purchase. The going concern rule also allows accountants to cater for transactions which overlap over two consecutive years, as is the case with many credit transactions.
The accounting period convention endeavours to address the problem which arises once it is assumed that a business will go on forever. People are interested in how a business is performing in terms of profit, but do not want to wait until the business ceases to see how successful it was. Therefore, the continuous life of a business is divided into equal periods of time for the purpose of calculating profit or loss. These arbitrary periods are known as accounting periods. The length of an accounting period may be a week, a month, a quarter, or a full year, but must not be any longer due to taxation requirements.
The matching principle endeavours to calculate a profit or loss figure for a accounting period by matching revenue for that period with the expenses over the same period of time. There are two basic methods of applying this matching principle.
- Cash accounting, where profit is calculated by matching revenue received with expenses paid.
- The accrual method where profit is determined by matching revenue earned with expenses incurred.
The consistency principle requires that the accounting methods used are applied consistently from one accounting period to the next. By applying the same accounting techniques, comparisons of performance can be made over time.
Verifiability is the concept that evidence should be available whenever possible to verify or check the details of financial transactions. Business documents such as invoices, receipts and cheque butts are the tools of verifiability.
Conservatism (prudence). Accounting, in some cases, involves a degree of estimation. It is generally accepted that when trying to predict the future, it is better to err on the safe side. There is a tendency to allow for all possible losses and to recognise gains if reasonably certain that they will occur.
General Accounting Concepts
In addition to accounting conventions and assumptions, accounting is also influenced by several underlying concepts.
· Relevance. Accounting information needs to relevant to the entity under examination. Only events relevant to the business entity are recorded and reported.
- Reliability. Because a wide range of financial decisions are made/influenced by accounting reports, there is a high expectation that such reports contain reliable information.
- Materiality. All significant items must be reported in accounting reports. This allows for immaterial amounts to be omitted. The test of whether items are material is whether or not their omission would influence financial decision-making. For example, materiality leads to the omission of cents in accounting reports as they have an insignificant effect on the users of accounting information.
- Comparability. Accounting reports are used to track changes in a firm’s performance over consecutive accounting periods. Users of reports must be able to compare results from different years. In order to do this, the same methods must be applied consistently from one accounting period to the next.
As economies grew, companies became bigger and more complex. The need arose for a set of commonly applied and accepted standards which could be followed by accountants.
Standards were established in many countries over the 20th century and as time moves forward, many countries move to align increasingly with each other through adoption of international standards.
There may still be some variance from country to country.
For information on International Standards:
see the web site of the International Accounting Standards Board
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